KEY POINTS:
Reserve Bank governor Alan Bollard is expected to deliver another official cash rate cut on Thursday, amid signs that consumers are starting to cheer up.
Consumer confidence, as measured by the fortnightly Roy Morgan survey, has rebounded strongly since early July, even if it is still low by historical standards. Business confidence also climbed in the National Bank's August survey.
Economists attribute the rebound in sentiment to Bollard having embarked on an easing cycle on July 24, the prospect of tax cuts next month and an 8 per cent fall in petrol prices from their mid-July peak despite a weaker Kiwi dollar.
"It does suggest we may almost be past the worst, provided the global economy does not drag us down in 2009," said Deutsche Bank chief economist Darren Gibbs.
When Bollard cut the OCR to 8 per cent six weeks ago, he foreshadowed further cuts, provided the inflation outlook continued to improve and there was no "excessive" drop in the exchange rate.
Retail sales shrank in real terms in the June quarter and economists expect June quarter gross domestic product, due to be released on September 26, to confirm the economy was in recession in the first half of the year.
"The Reserve Bank's hypothesis - and it's a reasonable one; it has typically happened in the past - is that weaker growth will deliver lower inflation over the medium term," Gibbs said.
"And right or wrong, it's an assumption that is unlikely to be tested seriously by the economic data this side of Christmas, so we will continue to get [OCR] cuts over the next three reviews this year."
The dollar has dropped 4.5 per cent on a trade-weighted basis since the last OCR decision, but that was unlikely to disturb the Reserve Bank, Gibbs said.
ANZ's export commodity index dropped 3.3 per cent in world price terms last month - the steepest monthly decline for seven years - but the weaker exchange rate pushed the index 2 per cent higher in New Zealand dollar terms.
But while the weaker dollar buffers exporters against lower world prices, it pushes up the price of imports at a time when inflation is already 4 per cent and is expected to get close to 5 per cent in the September quarter.
Two-year inflation expectations hit 3 per cent in the Reserve Bank's latest survey - a record in the 20 years since the bank was given the mandate of containing inflation.
Westpac chief economist Brendan O'Donovan said lower fuel prices would take some of the edge off inflation in the near term, but by leaving more money in people's pockets to spend on other things they would boost activity, and therefore inflation pressures, over the medium term.
O'Donovan expects the OCR to be cut by another full percentage point over the next six months.
But like other market economists, he warns that the global credit crunch is continuing to raise the cost of borrowing abroad for New Zealand banks, which could limit the extent to which those OCR cuts flow through to lower mortgage rates.
Bank of New Zealand chief economist Tony Alexander said the economy continued to struggle with resource constraints: labour shortages, a tenuous electricity supply, roading bottlenecks and a telecommunications system that "still needs a lot of work".
These constraints meant that for any given rate of economic growth, inflation would now be higher on average than in earlier years.
Alexander said there was a consensus among economists that the cash rate would head down to 7 per cent over the next five months.
"But then things start to split, with some forecasters expecting the rate will continue down to 6 per cent, but most thinking the Reserve Bank may pause to assess the impact of the cuts so far."
